Rate rise likely as inflation hits nine-year high

City speculation about a fresh increase in interest rates in November intensified yesterday after the latest snapshot of the cost of living showed higher prices for a range of high-street goods pushing inflation back to its highest level under Tony Blair.

More expensive toys, games, furniture, household equipment, clothing and footwear reinforced the pain on consumers from the latest tranche of price increases for electricity and gas, according to data from National Statistics.

Inflation as measured by the consumer prices index (CPI - the government's preferred measure) rose from 2.4% in July to 2.5% in August, a level reached in only two months since Labour came to power in May 1997 and the highest since the series was launched in January 1997.

Separate data from the Alliance Trust Research Centre showed that the elderly are being hit hard by rising energy bills, which account for a bigger chunk of their monthly income than for the population as a whole. The inflation rate for the over-75s is running at 3.9%, the thinktank said.

Although some analysts said the recent drop in petrol prices would knock up to 0.4 percentage points off the inflation rate in September, the City now regards the Bank of England as being more likely than before to raise interest rates to 5% this autumn.

The Bank's mandate is to hit the 2% inflation target set by Gordon Brown. The Bank's governor, Mervyn King, would have to give an explanation to the chancellor should inflation, as measured by the CPI, rise above 3%.

David Brown, an economist at Bear Stearns, said: "It is quite clear that UK inflation tendencies are moving in the wrong direction for the Bank of England, leaving the bias in UK rate policy definitely pointing higher."

David Page, an economist at Investec, said: "Inflation appears to be coming in above the Bank's August forecasts (which were already pessimistic) and inflation expectations remain around the top of the range seen over the last six years. We continue to see the Bank hiking rates to 5% in November."

Over the past decade, cheap imports -particularly from China - have helped to suppress UK inflation but this aspect of globalisation has recently shown signs of wearing off. With consumer demand robust, prices of goods were up 2.2% in the year to August, compared with a 1.8% rise in the year to July. Officials said goods inflation was at its highest since the CPI was first published almost a decade ago.

Inflation also picked up when measured by the government's alternative yardsticks. The all-items retail prices index (RPI), the benchmark for many pay settlements, showed the cost of living nudged up from 3.3% to 3.4% in the year to August, while the RPI excluding mortgage interest payments - previously used by the Bank when setting interest rates - rose from 3.1% to 3.3%.

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